Question

jackson industries recently purchased a machine critical to their production process at a total cost of $980,000 with no estimated salvage value. operating and maintenance costs for the machine are $97,500 per year. unfortunately, the machine has not been performing as hoped, and jackson has three options to deal with the problem. the first option is to spend $200,000 upgrading and repairing the machine, which would add five years to the useful life of the machine. it would also reduce the annual operating and maintenance costs by 8.5%. the second option is to simply keep the machine as is and make sure maintenance is completed regularly. this would increase the operating costs by approximately $15,000 per year. the third and final option is to replace the machine with a newer model. this model costs $1,375,000 and jackson would be able to sell their current machine for 12% of the original purchase price. operating and maintenance costs would be reduced to $90,000 annually, and production would increase by 10%. jackson industries sells 90,000 units annually, with a contribution margin of $25 per unit. at the end of its useful life, the new machine could be sold for $150,000. if the relevant timeline is five (5) years, which option should jackson industries accept and why? wiley

Answer 1

Jackson Industries should select Option 3, replacing their machine with a new model, as it provides the lowest total cost over five years, considering reduced operating costs, increased production revenue, and salvage value.

Step-by-step explanation:

Jackson Industries must evaluate the total costs associated with each of the three options for handling their critical production machine over the relevant period of five years. To determine the most cost-effective approach, we must calculate and compare the total costs for upgrading and repairing the machine, maintaining it as is, or replacing it with a new model.

Option 1: Upgrading and Repairing

Initial upgrade cost: $200,000

Reduced annual operating costs: $97,500 - 8.5% = $89,212.50

Total cost over 5 years: $200,000 + (5 * $89,212.50) = $646,062.50

Option 2: Maintain As Is

Increased annual operating costs: $97,500 + $15,000 = $112,500

Total cost over 5 years: 5 * $112,500 = $562,500

Option 3: Replace with New Model

Initial cost of new machine: $1,375,000

Sale of old machine: 12% of $980,000 = $117,600

Net initial cost: $1,375,000 - $117,600 = $1,257,400

Reduced annual operating costs: $90,000

Increase in production value: 90,000 units * $25/unit * 10% = $225,000 annually

Salvage value of new machine after 5 years: $150,000

Total cost over 5 years: $1,257,400 + (5 * $90,000) - (5 * $225,000) + $150,000 = $1,257,400 + $450,000 - $1,125,000 + $150,000 = $732,400

Jackson Industries should choose Option 3. Despite the higher initial cost, the new machine offers reduced operating costs, an increase in production and revenue, and a salvage value recouped at the end of five years that makes it the most economically favorable over the given timeline. The analysis does not include discount rates or the time value of money, but it indicates the pure cost standpoint within the next five years.